Citigroup yesterday unveiled plans to raise up to $19.6bn and return $20bn to US taxpayers in a move that will free the bank from heightened government supervision but could inflict further pain on its shareholders.

The decision, after months of tense talks with regulators, is a milestone for Citi, which was repeatedly bailed out during the financial crisis and was one of the last banks still subject to tough government restrictions on pay and operations.

The equity offering, which could be the largest ever by a US bank, will be a test of investors' faith in Citi's ability to compete with healthier rivals without government support.

Under yesterday's agreement, the US Treasury will sell up to $5bn of the bank's shares, reducing its 34 per cent stake in the lender to below 30 per cent.

The authorities have agreed to sell the rest of the government's stake within 12 months.

Citi will also terminate an insurance agreement with the Federal Deposit Insurance Corporation on some $250bn in toxic assets – a key condition for Citi's release from restrictions on bankers' pay.

As a result, Citi will cancel $1.8bn-worth of preferred securities held by the FDIC, leaving the regulator with a $5.4bn preferred investment in the lender.

Citi will also issue $1.7bn in stock to staff in lieu of cash bonuses and might sell $3bn in preferred securities in early 2010 if it needs more capital.

The measures taken to repay the $20bn from the Troubled Asset Relief Programme will result in a $10.1bn pre-tax loss in the fourth quarter but will save Citi $2.2bn a year in interest and amortisation expenses.